The announcement of a future spin-off of Honeywell's(NASDAQ: HON) advanced materials business caused a spike in the share price and some rare excitement for a stock that hasn't gone anywhere over the last three years.
But is it a temporary break in the slumber or the start of a significant move upward in the price? Here's what you need to know about Honeywell's latest news.
Honeywell cheers the market
The industrial company's stock price has been flat over the last three years compared to a 32% increase in the S&P 500. As such, investors are looking for a potential upside catalyst for the share price. The obvious candidate is a breakup to release value.
After all, former industrial conglomerates like United Technologies (now RTX, Otis, and Carrier Global), General Electric (GE Aerospace, GE Healthcare, GE Vernova, and others), and Danaher (Danaher, Fortive, Veralto, Envista, and Vontier) have done the same.
The general idea is that breaking up conglomerates will enable management to focus on core businesses and expertise while realigning the capital structure of the new companies. The result will be improved earnings, better access to capital, and a revamping of valuation. So in theory, Honeywell could break up, and the sum of the new companies will be greater than its current valuation.
It's an idea that finds favor with investors. A quick look at Honeywell's ratio of enterprise value to earnings before interest, taxation, depreciation, and amortization (EV-to-EBITDA) compared to peers in aerospace (RTX and Safran), industrial automation (Rockwell, Emerson Electric, and Schneider), and building automation (Johnson Controls and Schneider) shows a clear discount.
HON EV to EBITDA Chart
That's why the market got excited by the news that Honeywell would spin off its advanced materials business by the end of 2025 or early 2026.
Honeywell's restructuring
That said, the move looks more like the portfolio restructuring that CEO Vimal Kapur continues to undertake rather than the start of an inevitable breakup. There's little doubt that management has considered splitting up the company and restructuring it around what it identifies as three megatrends: the future of aviation, automation, and the energy transition. This frames the company in a way conducive to potentially breaking it up.
Furthermore, Kapur has been more aggressive in mergers and acquisitions than his predecessor, Darius Adamczyk, and has made over $10 billion in acquisitions since 2023 across all three trends discussed above.
Image source: Getty Images.
At the same time, according to Bloomberg, Honeywell is believed to be close to selling its personal protective equipment (PPE) business for $1.5 billion and could conduct an initial public offering for its quantum computing business Quantinuum for about $10 billion.
These moves indicate continued portfolio restructuring to focus on the three megatrends rather than preparation for a breakup.
Near-term headwinds, long-term growth
Honeywell's portfolio moves will likely result in some near-term pressure but prepare the company for longer-term growth. The former result might make it less attractive to separate the company, as the market can price companies on current earnings.
For example, on the second-quarter earnings call in July, chief financial officer Greg Lewis told investors that the profit margin for the company's aerospace technologies business would "decline modestly" in 2024 due to the integration of defense and space technology company CAES Systems. Meanwhile, margins for industrial automation are also expected to decline in the third quarter.
In fact, in spinning off its advanced materials business, Honeywell is arguably separating its strongest current non-aerospace business. According to Lewis, "energy and sustainability solutions and building automation will lead the group in margin expansion."
The advanced materials business currently sits in the energy and sustainability solutions (ESS) segment, and outside of aerospace and building solutions, it's the segment with the strongest growth this year.
What it means to investors
Honeywell investors shouldn't expect a breakup anytime soon or expect the portfolio restructuring to boost earnings in the near term. The restructuring is necessary, and it's what many investors were calling for.
It will take a while for the full benefits of the actions to shine through in Honeywell's earnings. When that happens, management might well consider a more significant breakup.
All told, Honeywell is a high-quality company. It will suit patient investors willing to hold for the long term and watch as management unlocks value in the portfolio, rather than those looking for an immediate catalyst like a dramatic breakup.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Danaher and Emerson Electric. The Motley Fool recommends GE HealthCare Technologies, Johnson Controls International, RTX, and Veralto. The Motley Fool has a disclosure policy.
